The aggravation of international tensions should not make us forget the current fragility of the economic and financial balances in which the stability of the dollar and the resulting confidence must play an essential role. In the past, taxes were successively assigned three missions: to finance public spending, then to contribute to the redistribution of income to correct inequalities, and finally, with the application of Keynesian principles, to act on economic activity by stimulating investment and household consumption through the budget deficit.
After decades during which wealth accumulated, even if it was not evenly distributed, and the exchange of goods and financial assets increased, the dollar was no longer just the instrument ensuring transactions between Americans but conquered a central role in the world economy. It first became the preferred means of payment for trade between countries. At the same time, it has established itself as the main currency used as a reserve by central banks. Finally, with the liberalization of the financial markets and the dominant position of the New York market, the dollar is now the first currency in which assets traded on the markets are quoted.
For a transaction to be successful, both parties must agree on the currency in which it is carried out. Until now, the acceptance of the dollar has been general despite the legal consequences to which the parties were exposed due to the extraterritoriality of American laws. If a transaction was carried out in dollars, American law applied in the event of a dispute. This disadvantage, which has sometimes had serious consequences for French companies or banks, has not significantly reduced the use of the dollar. Two factors could now challenge the supremacy of the American currency.
Political and trade tensions between Washington and Beijing have led the People's Bank of China, which held the second-largest dollar assets in its reserves after Japan, to sell them gradually but continuously. They replaced them with gold, which partly explains the rise in the price of the yellow metal, and with euro securities. The threat of tariffs has also led the country to begin a major movement to redirect its business investment and trade towards Southeast Asian countries. Not all of them accept payments in yuan, but the trend has begun, which has resulted in a decline in the use of the dollar.
The countries of the euro area have also begun to emancipate themselves, although the absence of a single financial market makes this choice more difficult to implement. The large current account surplus makes it unnecessary to borrow in foreign currencies, especially since the markets accept interest rates much lower than those they charge American debtors. Finally, the succession of hostile declarations against Europe by the occupant of the White House does not encourage European economic agents to favour the dollar either as a means of settlement or as the currency in which financial assets are denominated, even if the level of European investments in funds or companies listed on Wall Street remains high.
The combination of these geopolitical and economic factors has led to a severe decline in the dollar since the beginning of the year, despite the numerous interest rate cuts made by the European Central Bank. Its base rate is at 2% while the Federal Reserve keeps its rates above 4%, despite repeated calls by the President of the United States to reduce them, in contradiction with the independent status that protects the institution against political interference.
The dollar is not only a victim of the geopolitical context created by Donald Trump's many initiatives. The country's economic situation, with a heavy external debt and public deficits that are expected to increase as a result of the budgetary policy defended by the current US administration, is beginning to worry and this is another reason for the weakening of the dollar. Tariff hikes in a country with a large foreign trade deficit are fuelling inflation, which remains above 2%, prompting the central bank to keep its current rate.
If, finally, under political pressure, the Fed were to start cutting rates, the consequences on the level of the dollar would be immediate, which would increase the price of imported products, inflation and the external deficit. Since the creation of the euro, the exchange rate of the dollar has fluctuated sharply. At the beginning of 2018, one euro was worth $1.25. In the aftermath of the invasion of Ukraine, it was worth only $0.96. But these fluctuations were the result of market assessments of interest rate developments, central bank choices and the global economic context. At no time were they the result of major political disagreements between the leaders of the two continents.
Between Donald Trump taking office and today, the US currency has lost more than 12% as the ECB cut rates and the Fed kept its rates at twice as high. The evolution of the foreign exchange markets reflects the loss of mutual trust between Europe and the United States. Given that the Fed is unlikely to choose to defend the dollar by raising rates, and that it is not impossible that under political pressure, especially in the run-up to the budget vote and the midterm elections, it will finally agree to reduce rates, we should see a further decline in the dollar.
The announcement of a ceasefire between Israel and Iran, if it is not called into question within three days, as has already happened following Donald Trump's statements, can be a first step in the normalization of the United States' action on the international scene. But it will have to be followed by several others, and in particular by a reversal of the discourse vis-à-vis Europe, including the United Kingdom, if we want to restore confidence between the two sides of the Atlantic, an essential condition for the return of a certain financial stability.
Three factors will guide the evolution and therefore the status of the dollar in the coming months. The first and most important is the economic policy of the United States. The country can no longer act as if it were allowed everything, including massive internal and external deficits, and believe that the whole world will finance its excesses while accepting tariffs that penalise international trade without reacting. The adoption of a budget and structural reforms to reduce the deficit must be a first step.
Only the restoration of confidence, which would allow the country to escape the threat of an inflationary recession, could then encourage the Federal Reserve to gradually lower its rates without this having any significant consequences on the dollar's exchange rate. By reducing the cost of public debt and therefore of its deficits, it would contribute to the essential restoration of financial balances.
Finally, the beginning of a new era in relations between the United States and the world's major economies, and in particular Europe and China, can help to recreate peaceful relations and allow the American currency to maintain its status. Otherwise, the era of the dollar-king, which has conferred a major privilege on the United States, will be definitively closed.